The last quarter’s GDP figures ended the “phony war” debate over whether we’re in recession. Now that we’ve had our “Dunkirk moment”, it’s time to consider what policy should be, given that avoiding a recession is no longer an option.
A first step there is seeing why we recovered from previous recessions, and asking whether we can pull off the same trick again this time.
The 1990s recession saw private debt to GDP ratio top out at 85% in late 1990, and then fall to 76% by early 1994. From then it took off once more, with households taking over the borrowing binge mantle from business, which actually reduced its debt level from 56% of GDP to 40% in mid-1995. The household debt binge, which began in 1991 in the depths of the Keating recession, took the household debt-to-GDP ratio from 30% to a peak of 99%, from which it is now falling.
Meanwhile, business borrowing likewise began a China and private equity fuelled blowout in mid-2004, rising rapidly from 46% of GDP to 66% — a new record — by early 2008. The combined debt total reached 165% of GDP in March 2008, and it has since fallen to 160%.
So what are the odds of encouraging businesses or households to start borrowing again, from their now record levels of debt?
Not good, I would think. Instead, they will be deleveraging, not just for the duration of a standard recession, but perhaps for a decade or more, to bring debt levels back to something like 1960-70 levels of 25-50% of GDP. Deleveraging has only just begun, and it has a long, long way to go.
So we can’t encourage businesses to borrow, or households. Who else does that leave?
And the bingo award goes to Kevin Rudd: government can get into debt instead. That is what is now happening of course, and from a position in which the government’s debt to GDP ratio is currently close to zero. So it has capacity to borrow and thus boost demand, but how does that weigh up against what the private sector might do in the opposite direction?
Not well. Rudd’s stimulus is a whopping $42 billion — a big number. But our private debt is now over $2 trillion. If the private sector delevers by as little as 5% of its current debt level, that will withdraw $100 billion from spending. In the new economic rock vs scissors game, deleveraging trumps government stimulus every time.
This is why Japan is still mired in a depression, 19 years after its bubble economy burst. You can’t solve a problem caused by too much debt by going into more debt. Ultimately, the only solution is to reduce debt.
Therefore Australia is in a quandary. We don’t yet have insolvent banks — the USA, on the other hand, has nothing else. So drastic means of attacking the problem are possible in America, once the Yankees get over their usual pussy-footing about nationalisation. But we can’t follow that path while it still appears that our banks are solvent.
So all we can do is brace ourselves for a massive increase in unemployment, and do what we can to ameliorate the pain. Several policies are obvious there: remove the waiting period for receiving the dole, eliminate (or drastically prune) the requirements that unemployed persons exhaust their savings before they receive the dole, get rid of the punitive job application requirements, and take the stigma away from being a victim of a global financial crisis that is well beyond the control of those whose jobs will be destroyed by it.
That will necessitate a massive increase in the government deficit, but that is justified in making sure that the pain of a depression is shared more equitably. It is also a far more sensible way of going into deficit than throwing a fistful of money at soon to be unemployed consumers.
We can also change the rules on mortgage defaults, so that a failed borrower becomes a renter from the bank or lender that extended the money, and pays a rent based on a proportion of their income. That might mean a lot less revenue for banks, but it will also mean a lot less mortgagee sales — and there will be a tsunami of those coming our way if the economy continues to shrink by 0.5% or more every quarter.
On that front, the most recent figure was a drop in the bucket compared to what we’ve already seen overseas, and what we are likely to see here as deleveraging reduces debt-financed spending, our terms of trade collapse and our export voumes plummet.